Recently a colleague told me how to get a great rate of return. His idea was not new, in fact it is repeated over and over throughout the nation. The “discussion” came up when we were talking about a recent purchase my wife and I made on a new dining room table set. He thought it was weird that we did not take advantage of the store’s generous “6 months no money down and No interest” financing. He believes it would have been better to take that money and invest $3,000 into a 6% return vehicle while paying off the balance in 364 days. The math is sound, right? But there are so many variables when it comes to debt that his plan just doesn’t hold water.
Let’s use the MATH to consider his way of thinking:
FACT: $3,000.00 borrowed at 0% for 12 months will cost you $3,000.00 in 364 days. Fine.
“INTEREST’ing FACT: $3,000.00 put into a 6% CD (pretend with me here) would produce around $169 in interest. Yes.
SO–SO fact: In 365 days you could pay the $3,000.00 no-interest loan off and pocket $169.00. Sounds great!
However, he did not take into account OTHER IMPORTANT FACTORS:
RISK: What if you couldn’t pay the loan off in 12 months? You would have to pay for all the back-charged interest. If it were 24% then you would end up paying a total of $3,804.73. That’s not a deal.
And more RISK: If you follow this thought process of borrowing to invest (that’s essentially what it is) then you probably don’t have an emergency fund. Example: If you needed money to replace the broken air conditioner then would probably take out another loan or you could cash out the $3,000.00 CD.
Side notes: Cashing out a CD before the maturity date will be penalized (essentially you pay a fine for taking your own money out of a CD). If you had put the money into anything else with a greater chance for a better rate of return (stocks, bonds, mutual funds, real estate), then 1) the money would not be as liquid 2) you take a HUGE risk of the investment going down in value (losing money).
BUT, WAIT FOR IT ………… THE BEST PART!
We walked into that furniture store with cash. We worked a deal with the salesman. Instead of paying full price and getting 0% financing we paid less by paying cash. That $3,000.00 dining room set we bought was listing for over $4,300.00. So we got the whole thing for 70% of the listed price, or 30% off. Yes, that is a REALLY GOOD rate of return.
AND THE MOST IMPORTANT THING:
I have to wonder what his wife would say about his investment plan. Hmmmm.